What is an unearned income tax return?

Written by denise caldwell

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Knowing the difference between earned and unearned income can be a big help during tax time. (tax forms image by Chad McDermott from Fotolia.com)

Under Internal Revenue Service (IRS) tax law, unearned income and earned income are two distinctly different types of income. Based upon this distinction, the IRS treats the two income types differently, though it is all placed on the same tax return.

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Definition

Unearned income is considered to be that income which is not from wages, tips, or salaries. Examples of unearned income include income from capital gains, Social Security, child support and interest income. Some unearned income, such as Social Security, is non-taxable unless combined with other income, while income like capital gains is always taxable income.

Earned Income

Generally, earned income is given a preference in the tax code because it is income that taxpayers actually worked to earn. For example, certain credits require that a portion of your income be from earned income in order to qualify. Examples of earned non taxable income includes military housing allowances and ministry housing allowances, while examples of taxable earned income include wages and salaries.

Eligibility Implications

In order to qualify for many IRS deductions and credits, you must have a certain amount of earned income. For example, in order to qualify for the Earned Income Credit, the IRS requires that you have earned income, and that your investment income be no more than £2,015. There is also an upper income limit for using the Earned Income Credit.

Considerations

Although earned income is sometimes given preferential treatment where some deductions and credits are concerned, it is sometimes taxed at a higher rate than unearned income. For example, net capital gains are taxed at a rate no higher than 15 per cent, and sometimes 0 per cent.